Firms File Before New Chapter 11 Rules Take Effect Monday

By Jennifer Mann, The Kansas City Star, Mo.

Oct. 13–When auto parts maker Delphi Corp. filed for bankruptcy last Saturday, its timing was tied in part to changes to Chapter 11 rules that will take effect Monday.

Delphi isn’t the only company believed to have taken the coming changes into consideration in deciding whether to file for bankruptcy before the new rules take effect.

Airline analyst Helane Becker with the Benchmark Group in New York cited the recent bankruptcy filings by Delta Air Lines and Northwest Airlines as other examples. Becker said both carriers were being squeezed by soaring jet fuel costs, “but I definitely think the coming changes also came into play.”

While much attention has been focused on how new bankruptcy rules, pushed by the banking and credit card industries, will be more onerous for consumers, little has been noted about changes to Chapter 11 codes.

There are a number of changes, from how quickly companies must decide what real estate leases to cancel, to restrictions on paying so-called retention bonuses to keep key employees from bolting, to how quickly companies must put into writing a plan for paying debts and becoming profitable again.

While not creating the rush of debtors trying to beat the deadline that changes in the personal bankruptcy rules have caused, a recent uptick in Chapter 11 filings suggests some companies have decided they would rather reorganize under current rules. Last-quarter filings in the busiest jurisdictions were up almost 20 percent, according to data compiled by Bloomberg News, while filings in all jurisdictions were up 8.3 percent in the same period.

In all, the changes to Chapter 11 laws represent a hodgepodge of interests, said Ben Mann, a bankruptcy attorney with Blackwell Sanders Peper Martin in Kansas City.

“Unlike the consumer side, which was very focused, there wasn’t an overall goal with these changes,” Mann said. “Each change in Chapter 11 has its own mini-goal.”

The changes are generally viewed as making the bankruptcy process more onerous and expensive for companies seeking protection from creditors. Some bankruptcy experts also believe it is an effort by Congress to curtail judicial discretion.

“The sense that is overarching is that Congress was distrustful of the discretionary powers that bankruptcy judges have,” said Karen Gross, a law professor at New York University. “And then some of the changes come from the perception that Chapter 11 has been too debtor-friendly.”

U.S. Bankruptcy Judge Jerry W. Venters agreed with Gross’ characterization of Congress’ intent.

One change gives a company 18 months to file its plan to reorganize. After 18 months, any interested party can file its own plan, which shifts some power away from the company to those owed money. Under current rules, companies have 120 days to file a plan, but judges have the discretion to extend the deadline indefinitely and often do.

“This (change) is reflective of Congress’ desire to take away some more discretion from the court to let (the parties) work things out,” Venters said. “The underlying philosophy up until now is that bankruptcy should provide protection and relief for companies and people who are in financial difficulty — the new law is not written in that manner.”

John Penn, president of the American Bankruptcy Institute and a lawyer in Fort Worth, Texas, said he wouldn’t be too surprised to see at least a few large, high-profile companies file for reorganization before Monday to beat the changes in the law that he thinks companies will find taxing.

For instance, the new rules dictate that any goods delivered to a company in the 20 days before filing for Chapter 11 are administrative claims and may have to be paid in cash in the early stages of the case.

Under current rules, those bills are general unsecured claims and are paid at the end of the bankruptcy process after secured lenders are paid — if there is any money left over.

Penn used Interstate Bakeries Corp., which filed for Chapter 11 a year ago, as an example of how the rule changes may affect companies. “Think of all the flour and sugar delivered in the 20 days before they filed,” Penn said. “That would be a lot of money they’d have to pay out during the start of the bankruptcy process.”

Another change Penn noted that will make the process more expensive and arduous deals with utilities. Under current rules, at the beginning of the process, a company has to provide so-called adequate assurance to utilities that it will continue to pay its bills. Normally, courts rule it is adequate for a company to simply show it has money to pay utility bills.

The new law typically will have companies make a cash deposit, issue letters of credit or secure surety bonds equal to two months to each utility. Again, using Interstate as an example, it would have had to make arrangements and cash outlays to the hundreds of utilities that service its approximately 50 plants, 1,000-plus thrift stores and about 700 distribution depots. Interstate spends $1 million to $2.2 million monthly on utilities, meaning it would have needed to pony up $2 million to $4.4 million at the start of its reorganization.

Another change to the code deals with the time a company has to assume or reject leases. Now a company has 60 days to decide what leases to keep and which to reject. But they often ask for and are granted time extensions by the courts. The new law gives a company a maximum of 210 days, unless it asks for and receives permission from landlords to delay such decisions.

Again, Interstate would have likely had to make all decisions within that time frame, when in reality it would have been at best only halfway through that process more than a year after its filing.

Yet another change deals with bonuses paid to so-called key employees, often the top executives, to stay with a company through its reorganization process. Previously, a company could identify people it said were key to successfully reorganizing and ask the courts to let them pay them bonuses to stay on so the company would not lose institutional knowledge useful in reorganizing. Under the new rules, a key employee would have to receive a bona fide offer from another company for an amount equal to or more than the bonus amount before the court could approve such payments.

This change, said Gross of NYU, “is an effort to root out certain kinds of wrongdoing by corporate officers,” citing Enron as an example. On the eve of Enron’s bankruptcy filing in 2001, 292 executives collected bonuses as large as $8 million. Shortly after it filed, it asked for and was granted approval to pay up to $45 million to key employees.

Last week, on the eve of its Chapter 11 filing, Delphi sweetened severance packages for 21 top executives and then filed a motion with the court for bonuses for key employees that would give them cash and a stake of up to 10 percent of the company that could add up to $87.9 million.

But Venters said the changes to the retention bonuses are troublesome to him. In his experience overseeing bankruptcy cases, keeping key employees has often made bankruptcies run more efficiently.

“I sat in Delaware handling larger cases than we typically have around here, and given the experience with Farmland and Interstate, that’s bothersome because I’m convinced it’s important to keep the people who know the business,” Venters said. “Now they’ll have to find another way to keep those key employees.”

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